With inflation rising and recession fears, pay attention to these 3 key numbers in corporate earnings reports

By Andrew Keshner

This earnings season comes as investors have a series of nagging questions about the economy.

People deciding where to invest their money – or even if they even should – ask themselves questions about the possibility of a recession, the degree of inflation that is stifling consumer demand, and when prices will could drop.

Now that earnings season is about to begin, they’ll get the answers from Corporate America.

Starting this week and running through July, publicly traded companies across the country are expected to reveal their second-quarter earnings and share their best guesses on what to expect for future results.

The big banks kicked off the season on Thursday with the report from JP Morgan (JPM) and Morgan Stanley (MS). Shares of both banks were down on Thursday after earnings missed estimates. Companies such as Bank of America (BAC), Tesla (TSLA), Netflix (NFLX) and American Express (AXP) are expected to report next week.

The parade of profits, losses and projections occurs quarterly under US rules. The figures also offer insight into the financial health of consumers and the economy in general.

This time, the earnings season coincides with a volatile bear market that is rocked by all sorts of questions: what to make of Omicron’s subvariants or China’s lockdown policy and its supply chain implications? ? Where are oil prices headed as the Russian invasion of Ukraine continues?

How has US consumer demand weathered high inflation for four decades? That point was underscored by Wednesday’s inflation data showing the cost of living rose a more than expected 9.1% year-on-year in June.

And, of course, what is the chance that all of this will result in a recession?

Don’t dismiss earnings reports and calls as public relations because they can provide real insights, said Bryan Routledge, a professor at Carnegie Mellon University’s Tepper School of Business. And useful information is now scarce, he added.

“Information is more important when the world is more unstable. … The range of information, the slew of things that could influence those revenues, are much more important now than the simple world we lived in three years ago. ”

The Dow Jones Industrial Average, S&P 500 and Nasdaq Composite all opened sharply lower on Thursday. The Dow Jones lost about 550 points, or 1.8%, the S&P fell 1.5% and the Nasdaq fell 1.4% as investors braced for earnings season and pondered the next decision of the Federal Reserve to control inflation.

Stock picking is risky business

“There are more questions to answer this earnings season than any previous earnings season that I can remember,” said Victor Jones, chief global strategist at tastytrade, which offers brokerage services and a training of traders. They include how consumer behavior changes and who benefits — not — as a result, he said.

“Answering questions, instead of more questions, would be a welcome phenomenon for market participants at this stage,” Jones added.

Company cash flow, profit margins and any forward guidance are three important things to get answers to, Jones and other experts told MarketWatch.

Then it comes down to whether investors with quarterly results should even act on those answers.

Stock picking is risky business in any market, let alone this one. The same goes for quick buys and sells based on earnings results, especially during the extended session when many companies release their numbers.

But if retail investors want to take a chance, it’s best to make informed decisions. The same is true if investors want to do due diligence on companies they already own, or if they want to check the stocks a fund manager selects for a mutual fund. This earnings season, here’s a primer on what to look for, according to the experts.

1. Cash flow

Investors looking for solid company data points in unclear times can start by looking at a company’s cash flow, said Mychal Campos, chief investment officer at Betterment, which offers financial services including bots. advisers. In the broadest sense, a company’s “free cash flow” is the cash still available from its operating activities, after capital expenditures have been subtracted.

While some metrics can give company earnings a more rosy hue, Campos said free cash flow is a good way to get “more signal from the noise right now” about a company’s ability. to operate.

Speaking of assets and liabilities, it’s worth considering a company’s debts, Campos said.

Like consumers, indebted businesses face more challenges when interest rates rise, he said. After three interest rate hikes already this year, the Federal Reserve looks set to continue.

As interest rates rise, debt becomes more expensive and borrowing costs rise, and if there’s a downturn, that could be even more problematic for a company’s balance sheet, Campos said. (The same goes for someone carrying a credit card balance these days.)

2. Profit margin

Investors will also want to know how companies are managing spending, between price and wage inflation to keep workers in a tight job market, Campos said.

They can find the answers in the talk of profit margins.

“Net profit margin is important to watch because it indicates how well companies are managing higher costs,” said John Butters, FactSet vice president and senior earnings analyst. “With inflation at some of the highest levels in 40 years, businesses are facing rising costs. As costs have risen in recent months, many businesses have raised prices to maintain margins and their profits.

Net profit margin shows the amount of profit a company creates for every dollar of revenue it generates, Butters said.

As of Tuesday, S&P 500 companies are expected to report net profit margins of 12.4% in the second quarter, according to an aggregation of analyst estimates collected by FactSet. That figure would be above the five-year average and just above last quarter’s 12.3%, Butters said – but is “down from the 13% figure a year ago”, he said. he noted.

If margins decline, “the costs needed to generate revenue essentially increase relative to the revenue generated,” Campos said. According to Goldman Sachs (GS) analysts, the so-called “margin squeeze” could prove to be a real drag on earnings.

Margins and cash flow are “likely going to be top of mind for investors,” Jones said, as they provide “an understanding of who’s managing and create predictability for investors.”

3. Indications of income

Companies aren’t required to provide forward-looking guidance on what to expect for future profits and revenue, but experts said it can be informative when they do. Butters is always monitoring advice to see how it compares to analyst estimates and previous advice.

That’s especially the case this time around, Butters said, as “earnings guidance is important because it will provide more clarity on economic conditions given the market uncertainty.”

The tone of advice matters a lot, Jones noted. Something that seems overly optimistic or rooted in assumptions about the start of the pandemic could raise eyebrows among investors, he said. “I think investors will have more confidence in the future of more sober leaders, odd as that may seem at this point.”

-Andrew Keshner


(END) Dow Jones Newswire

07-15-22 1854ET

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